The Federal Reserve’s two-year battle to tame inflation is turning into a drawn-out war, with the central bank grappling with prices that have run surprisingly hot this year. A major reason: stubbornly high housing and rent costs that have sapped household budgets across the U.S.

The Fed will be scrutinizing the latest Consumer Price Index report on Wednesday morning for signs that its campaign to finally extinguish runaway inflation by pushing up interest rates is working. Wall Street expects a slight improvement, with economists forecasting that the CPI in April rose 3.4% from a year ago, a tick lower from March’s 3.5% increase, according to financial data company FactSet.

Still, 3.4% remains far higher than the Fed’s target of 2% inflation. Fed Chair Jerome Powell on Tuesday acknowledged that his confidence that inflation is set to ease “is not as high as it was.”

One major driver of inflation is housing, which contributes about one-third of the CPI and which economists predict could remain a thorn in the Fed’s side throughout 2024. That’s creating something of a catch-22, given that the Fed is holding off on cutting interest rates until it sees more progress on inflation; that, in turn, is keeping borrowing costs elevated, including mortgage rates, which are now near a 20-year high.

The so-called shelter portion of the CPI is capturing the price shock of people who are moving into new apartments after remaining in place for years. Such renters are more likely to experience a sharp increase in their housing costs as they jump from lower-cost apartments to market-rate rents, Zillow chief economist Skylar Olsen told CBS MoneyWatch.

“The big ‘a-ha’ is that the full CPI is capturing the people that haven’t moved in a while,” Olsen said. “The fact we keep having people move who haven’t moved in six to eight years, that will keep that growth up.”

But aren’t rents cooling?

It could take years for such data to cycle through the housing portion of the CPI because some renters continue to move from their long-term — and cheaper — housing into market-priced apartments, Olsen noted. 

But as many apartment hunters may know, rents are actually cooling now, thanks in part to new rental units built in recent years to meet growing housing demand. In some cities, rents are actually falling — but don’t expect that to show up in the CPI data for a while longer, economists said.

As of April, the monthly rent for a typical 1-bedroom apartment around the U.S. was $1,486, down 0.6% from a year ago, according to listing service Zumper, while 2-bedrooms hovered around $1,843.

At a May 1 press conference, Powell hinted at this dynamic, noting that the Fed has been surprised by the length of time it’s taking for the CPI’s data to reflect the cooler rental market. He added that while he’s confident the CPI’s housing data will eventually reflect that decline, he’s “not so confident in the timing of it.”

“Those market rents take years, actually, to get all the way into rents for tenants who are rolling over their leases,” Powell said. “It’s complicated, but the story is it just takes some time for that to get in.”

Homeownership and affordability

The CPI has another quirk when it comes to tracking housing costs: It doesn’t actually track home prices, because it considers housing values to be an asset, similar to stock prices, which also aren’t tracked by the inflation index, noted Lawrence Yun, chief economist at the National Association of Realtors. 

Instead, the CPI measures homeownership costs by tracking what it calls owners’ equivalent rent, or the hypothetical amount that a homeowner would pay to rent their house in the current market.

But that’s also sparked debate among some economists, given that most homeowners are locked into 15- or 30-year mortgages at fixed interest rates and thus aren’t subject to the pricing whims of the housing market.

“Homeowners aren’t feeling any impact of the housing rents, because their monthly payment is absolutely fixed,” Yun noted. “Their mortgage costs aren’t rising according to the inflation number, but it’s not part of the CPI.”

Home prices, of course, are very important for first-time buyers who want to make their first home purchase, although that’s not a figure that is reflected by the CPI, Yun added. 

The Fed’s decision to delay cutting rates may be contributing to stubborn housing inflation, said Rakeen Mabud, chief economist of Groundwork Collaborative, a progressive advocacy group that is urging the central bank to start cutting rates.

“When the Fed raises interest rates, mortgage rates rise too,” Mabud said in a social media post. “That means that many prospective homebuyers are priced out of the decision to buy a home. Where do these potential buyers go? Back into the rental market, increasing demand among renters and pushing up rent costs.”